The demonetization of the high valued currencies was expected to lower the Indian GDP for the current quarter. According to preliminary estimates the Indian GDP will grow only by 7.1%. Illiquidity is believed to have hit the consumer demand as well as investment. In the meanwhile the Central government has announced that the tax buoyancy has increased immensely thanks to indirect levy. Former Finance Minister Mr. Chidambaram raised an issue about how this can be true given the economy is slowing down and based on the maxim “more economic activity more tax collection” and vice versa. This is a conversation between a student and his professor.

Student: Professor, I read in the newspaper that the tax collection as a proportion of GDP has gone up. How is this possible?

Professor: This may be due to lag. The tax is based on previous growth. While the current growth is modest, previous economic growth was in line with expectation. According to the data available for 2013-14 the final year of the UPA regime the tax buoyancy hit a four year low of 0.71%. Currently it is 1.35% in 2015.

Student: What is the relevance of increase income through taxes?

Professor: Every year our budget has a deficit of around 3.1% of the GDP. Currently the budget revenue falls short by 5.3 trillion rupees. With the increased tax revenue this deficit will either the maintained or brought down. My feeling is that monetization exercise is going to work as a magic for Indian taxation. Currently there are only 3.65 Crore people out of 130 Crore people filing IT returns of which only 1.9 Crore people paid closed to 2.86 Lakh Crore Rupees. This monetization scheme brought nearly 7 Lakh Crore (7 X 1012) Rupees into the bank deposited by 60 Lakh people (6 X 105). When divided among contributors the number of people who will now come under tax levy will increase multifold. This means that the direct tax collection will increase significantly.

Given that the indirect taxes are improving. Our government will be very comfortable with the tax revenue situation. A steady increase in service tax collections as the net was widened and additional cess is one of the main reasons for increased tax revenue.

Student: While the direct tax hits the rich income earner the indirect tax hits everybody including the poor. Is this fair?

Professor: I am not able to answer this. You are right. Indirect taxes are inequitable as they tax the rich and the poor alike but tax collection is far easier. The question often asked is what should be the proper distribution between direct and indirect taxes. Some economic experts are of the opinion that eliminating income tax altogether and generate the total tax needs of the country through indirect taxes is the best possible way forward. They suggest that a tax be levied on every transaction and the revenue generated will offset the direct taxes. On the other hand some suggest tax agriculture income and long term capital gain. Let us see what the finance minister is going to do in the FY 2017 budget.